Porsche's slow, methodical takeover of Volkswagen
[First I'd like to take time to acknowledge the passing last Friday of automobile publishing magnate and car enthusiast, Bob Petersen. From his legendary magazines like Hot Rod and Motor Trend to the fantastic Petersen Automotive Museum at the corner of Wilshire and Fairfax, he was a real inspiration in everything automotive in LA. Read the full LA Times obituary here.]
The news over the weekend was that Porsche is has purchased another chunk of Volkswagen AG by exercising a pre-existing option. With the new shares, Porsche's ownership in VW rose from 27.3% to 31%. (Technically, the official ownership percentage is now 30.94 %.) Under German law, the 30% ownership threshold triggers a requirement for Porsche to make a tender offer for the rest of VW.
But who knew the German law was so toothless? I didn't know; but obviously Porsche management knew and took full advantage of the situation. Volkswagen shares closed up 6.2% last Friday at €117.95. Porsche's option was to purchase shares at €100.92. Not a bad deal given Friday's close. So here's the kicker. On Monday, Porsche offered to buy the remaining 69% of VW that it doesn't own for only €100.92 -- the "legal minimum price" under German law.
VW also has preferred shares. Porsche offered €65.45 per preferred share -- the average share price over the past three months. This Wednesday, the preferred shares were trading at €75. VW's common stock was down a bit at €112.48, but still trading at a significant premium over what Porsche is offering to pay.
So it's no surprise that there aren't many shareholders rushing to sell their shares at a steep discount to market price. But I'd sure like to know all the insider trading that went on Friday in advance of Porsche's weekend announcement. If this was in the US, there would probably be an SEC inquiry -- but hey, this is very German.
Not so long ago -- in January -- Porsche management (CEO Wendelin Wiedeking) dismissed any idea that Porsche would need or want to increase its ownership stake in VW to the magical 30% threshold. Of course, we now learn that was all bullshit and smoke screens. Porsche was just waiting for VW's stock to climb to a comfortable level so that when it exercised its option on VW stock at €100.92, it really wouldn't have to reach into its pocket for any additional cash and it would only have to go through the motions of a legal tender offer for VW stock to satisfy German law. Smart move, I guess.
The latest canard Porsche floated into the rumor ether is that with EU emission rules being tightened, small/economy car manufacturers like the French, Italians and Japanese will have an advantage over the Germans (Porsche, BMW and Mercedes) because German cars emphasize luxury, performance and horsepower over fuel economy. Porsche thinks it needs VW's fuel economy technology to help it compete in the EU with an ever-tightening carbon emissions environment. Blah, blah, blah...
But there is more to this move. The German State of Lower Saxony owns 20.3% of Volkswagen and has held these shares since VW's resurrection in the aftermath of WWII. If you read between the lines of the reports this Monday, there is some indication that for the first time, Lower Saxony may be willing to sell its stake in VW. And who better to sell to than Porsche? It's all in the German family, you see. Porsche is privately-held and the likelihood of that changing is near to zero. I have no doubt that there is already a secret backroom deal to make this happen. Porsche has its enormous checkbook wide open for a bargain. That's why 31% sounds so much better now. If you add 20.3% to Porsche's 30.94%, that would give the Porsche 51.24% -- complete voting control -- of VW.
I also learned some very arcane and little-publicized piece of tax law over the weekend. And lo and behold, it made the picture of this puzzle become clearer. If you are a regular reader, you know that I talk regularly about Porsche. One of the snazzy financial tools Porsche used to finance its spending spree on VW shares as well as the expensive development of the new Panamera 911 sedan, was something called "hybrid bonds".
These complex financial instruments are called hybrids because the bonds are delineated in different monetary units from that of the issuer's home country. Porsche borrowed about €2 billion from "normal" bonds and another $1 billion US. The hybrid bond doesn't have a fixed maturity date. It has something called a rolling maturity date. For German accounting purposes, the bond is considered "equity" not debt. That looks better on the limited financial statements Porsche chooses to release to the public. Porsche is still required to publish financial statements because Porsche's non-voting preferred stock is publicly traded in Germany.
But in a very arcane and unpublicized US tax provision, a US investor can buy the hybrid bond (issued by Porsche Irish subsidiary Porsche International Finance plc and guaranteed by Porsche AG) and the generous interest payments (7.2% stated interest rate), are considered a "dividend" (not interest) and subject to a maximum US tax rate of 15% as opposed to interest income which is taxed at ordinary income tax rates up to 35%. Nice trick if you are a wealthy investor, huh?
The interest payments made by Porsche International Financing plc are considered dividend payments, and are not considered an interest expense in calculating Porsche's consolidated net income. So profits can be inflated as needed. Very convenient!
[P.S. The IRS doesn't like to talk about this and some angry US companies -- who can't use the same rules -- want the provision repealed. Under US tax law, it's cheaper for foreign companies to borrow money through this arcane tax loophole that it is for US based issuers of debt.]
Porsche is getting some pretty expensive and sophisticated financial and tax advice. And you can be sure that the reason the finance company is located in Ireland is because there is some Irish tax provision where Porsche International Financing pays little or no tax to the Irish government on any profits.
All these financial transactions are taking place at a time when cross-town rival, BMW AG is quietly going about a share repurchase plan. Let's review that little financial deal for a moment. BMW, flush with record sales, profit and cash, is buying back its own shares. In and of itself, the buyback plan isn't remarkable. US corporations do this all the time to increase shareholder value and reduce the number of outstanding shares.
However, before the buyback plan, the Quandt family controlled about 47% of BMW. I believe the Quandt family now controls more than 50% of BMW, solidifying the family's control of BMW and sheltering BMW from any unwanted outside invasion. The BMW share repurchase plan was recently and quietly extended.
In an interview over last weekend, Mr. Wiedeking told a German magazine that Porsche was concerned about the intrusion of unidentified hedge funds that might try to take over and break up VW. If this is paranoia, it seems to be shared, albeit quietly, by the Quandt family. I predict that Porsche's next step, denied, of course, would be for Porsche to buy Lower Saxony's shares and take full voting control of VW AG. That would seem like the polite German thing to do, I think. Is there a quiet wealth contest going on between the Porsche/Piëch clan and the Quandt clan? I don't know, but it sure sounds like there is a shared goal to protect Germany's crown jewels from the likes of the smarmy American corporate raiders.
But where the Porsche/Piëch families differ is in the ambitious egomaniacal plans of Dr. Ferdinand Piëch, VW's once and current chairman and the guiding family member behind Porsche's never-ending quest to be the most profitable car company on the planet.
Under Dr. Piëch's short-lived predecessor, Bernd Pischetsrieder, VW underwent a significant cost reduction program that had already begun to payoff as 2006 profits more than doubled to €2.75 billion. The US market finally got the new Golf/Rabbit and GTI during Mr. Pischetsrieder's tenure. But that momentum now belongs to Dr. Piëch and his hand-picked lackey, new VW CEO Martin Winterkorn, former CEO of VW subsidiary Audi AG.
As Dr. Piëch's proxy, Mr. Winterkorn intends on driving VW by quality improvements and technical innovations. Of course what no one is saying is that quality control, including dramatically reducing warranty costs, was a major focus of now-fired VW Group CEO Wolfgang Bernhard. The main change is the realignment of management and reporting groups from horizontal to vertical to be more like Porsche. The Pischetsrieder/Bernhard plan never had a chance to work; but current management is happy to use them as the cost-cutting scapegoats and then take credit for the increased efficiency and profits.
It seems that Dr. Piëch has bigger plans for VW. He wants VW to be the German Toyota (god forbid). It's likely that with good product and expanding eastern European markets, VW will overtake Ford in terms of volume. But Piëch wants to take on GM (ok, that's the easy battle) and Toyota for global sales leader. Frankly, I wouldn't want to pick any fights with Toyota. I'd rather see VW concentrate on quality control, drivetrain innovation and new hip products -- products that have been lacking for so many years from the US market. Please give us a new Sirocco. And please kill the next-generation Phaeton (again).
But Dr. Piëch has never cared about the US market. In fact, during his reign as VW Chairman (1993 -- 2002), he oversaw a steep decline in VW's US market that led to massive financial and market share losses and a weakened dealer network. What next? How about a $75,000 Passat? That should go over well in the US market -- about as well as the $100,000 Phaeton W12. VW has so much potential, but with an insane egomaniac back in firm control, I worry.
